BROKER WORLD MAGAZINE
PETER L.
McCARTHY
JD, CLU, ChFC, is a senior
advanced sales consultant for
Voya’s insurance sales marketing group. He has more than 20
years of experience in advanced
marketing and practiced law as
an estate planning attorney with
a large Minne­apolis law firm.
He earned his JD degree from
the University of Miami (FL)
School of Law, an MBA from
Rollins College, and CLU and
ChFC designations from The
American College.
McCarthy can be reached by
email at Peter.McCarthy@
voya.com.
Skinny Benefits:
Jointly-Funded Selective
Benefit Strategies
R
ewarding Commitment
Many businesses have several key
employees who provide more value to the
organization than others. Their skills and
expertise are critical to keeping the business
successful. Key employees are hard to find
and difficult to replace. It could take a long
time to recover if one of them leaves or joins
a competitor. Businesses will provide extra
financial incentives to retain and motivate
key employees to stay with them for the
long term.
But structuring these incentives can be
challenging. Many businesses aren’t interested in incentive plans that require them
to do all the funding. They want their key
employees to be as committed to the plan
as they are. They want incentive plans in
which their key employees have “some skin
in the game.” They want their key employees to be personally invested in the plan
by contributing some of their own money.
“Skinny benefits” are incentive benefit
arrangements in which businesses and
key employees work together to build
the employee’s net worth and retirement
security. They both have “skin in the game.”
Rather than being a handout from the business, “skinny benefits” are a jointly-funded
strategy based on the idea that people
appreciate benefits more when they pay
part of the costs.
Cash value life insurance (CVLI) policies
are often used in skinny benefit incentive
plans. CVLI is regularly used because it provides several important potential benefits:
• Income tax-free death benefits for an
employee’s family if he dies prematurely.
Reprinted from BROKER WORLD April 2015
Used with permission from Insurance Publications • Income tax-deferred cash value growth
while the employee is working.
• The potential for income tax-free distributions to supplement the employee’s
retirement income.
“Skinny Benefit” Strategies
There are four commonly used skinny benefit strategies. We’ll review them in the context of Robert Smith (age 50), vice president
for sales and marketing at ABC, Inc. During
his five years with ABC, Smith’s efforts have
helped the company triple its revenues. ABC
wants to retain him and motivate him to
continue this productivity until he retires in
15 years at age 65. One day ABC’s president
asked Smith if he was saving enough so he
could retire on schedule. When Smith admitted he wasn’t and needed to save more, the
president said ABC would be willing to help.
He asked Smith how much more he thought
he could save toward retirement. Smith
indicated he could save $10,000 annually to
improve his retirement readiness.
1. The Salary Deferral Match Plan.
This strategy is sometimes known as a
401(k) look-alike plan. In it Smith and ABC
enter into a written deferred compensation
arrangement in which Smith agrees to defer
$10,000 of his salary during the coming year
and ABC agrees to match that deferral for
a total of $20,000. ABC will use the $20,000
to purchase a cash value life insurance
policy on Smith’s life to informally fund
the plan. This annual deferral and match
will continue until Smith turns 65. ABC will
maintain a bookkeeping account for Smith
which will be credited with the $20,000 in
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combined contributions. The agreement
specifies how growth on these contributions will be credited in the bookkeeping
account. Some options include using an
agreed upon interest rate, the performance
of a specified index (e.g., the S&P 500), or
mutually agreed upon investments. When
Smith retires, ABC will begin to pay him
the bookkeeping account balance under
the terms of their agreement. ABC can use
withdrawals or loans from the life insurance
policy to fund its payments to Smith.
This plan looks similar to Smith’s 401(k)
account in ABC’s plan. However, because
it’s a non-qualified plan, there are some
important differences.
First, Smith doesn’t own either the 401(k)
look-alike plan bookkeeping account or
the policy. ABC owns the policy, pays the
premiums and manages the policy as it sees
fit. Second, Smith’s benefits are not vested.
The agreement controls when and how
Smith will receive benefits. He is a general
creditor of ABC to the extent of the account
balance. ABC may use the policy to fund
Smith’s payments (after age 65) or it may
use other assets. Third, if Smith leaves early,
he may forfeit his benefits. ABC’s obligation
to pay money to Smith only kicks in when
Smith retires at age 65.
2. The Loan Match Plan. Either Smith
or ABC (or both) may decide that the salary deferral match plan doesn’t meet their
objectives. Smith may not like having to
wait fifteen years before starting to receive
any benefits from his $10,000 salary deferral
and ABC’s match. He may not like the fact
that some of his benefits are forfeitable and
that he may not have access to them in the
event of a personal or financial emergency.
On the other hand, ABC may not want to
incur the costs and problems that can come
from administering the plan. If Smith and
ABC want a simpler, more flexible way
to provide incentives, they may want to
consider a different strategy that uses
employment loans—the loan match plan.
In this approach, Smith will own the life
insurance policy and will pay the premiums
from a combination of personal funds and
a matching annual loan from ABC. The
loan match plan provides Smith with an
ownership interest in the funding, but still
provides ABC with some control over the
benefit and the potential for cost recovery.
In the loan match plan, Smith doesn’t
defer any of his salary. His $10,000 contribution comes from personal savings/assets
or after-tax salary. ABC matches this with
a $10,000 loan. This loan can be a demand
loan or a term loan lasting for a specific
number of years. It can bear an interest
rate that is at the current market rate (as
determined monthly by the IRS) or it can
have a below market rate. It could even be
an interest-free loan. Whatever method they
use for interest on the lone, the annual interest costs must be accounted for. Smith could
pay it personally or ABC could give him an
annual bonus to cover the interest costs.
Smith will execute a collateral assignment
of the policy to ABC to secure repayment
of the employment loans.
In this strategy Smith has $20,000 in
contributions working for him in the policy
immediately and ABC has a secured right
to recover its outstanding loan balance.
ABC gives Smith the use of outstanding
loan balance which (depending on policy
performance) could potentially grow into a
significant sum over time. If Smith manages
the policy correctly, cash value distributions
he decides to take should be income taxfree.* The loan match incentive gives Smith
an immediate life insurance death benefit
and cash value benefits that aren’t available
when ABC owns the policy under the salary
deferral match plan.
*Income tax-free distributions are
achieved by withdrawing to the cost basis
(premiums paid) then using policy loans.
Loans and withdrawals may generate an
income tax liability, reduce available cash
value and reduce the death benefit or cause
the policy to lapse. This assumes the policy
qualifies as life insurance and is not a modified endowment contract.
3. The Bonus Match. The loan match
plan can be effective, but over time the
incentive it gives Smith may diminish. He
may not find the additional life insurance
death benefits and the use of ABC’s money
to be a worthwhile incentive. If Smith owns
the policy, ABC could make its contribution
Reprinted from BROKER WORLD April 2015
Used with permission from Insurance Publications through a year-end bonus, instead of a loan.
It could even elect to make the bonus large
enough so that after paying the taxes due,
Smith would net $10,000 after income taxes
to match his own contribution of post-tax
dollars. This is often called a “double
bonus” plan. Smith would purchase a
CVLI policy on himself with the $20,000
premium (the sum of his own savings and
ABC’s after-tax bonus). He would own the
policy personally and continue to pay both
the premiums and the taxes on the bonus
each year.
The bonus match strategy could be appealing to Smith and it could also have some
benefits for ABC. Since ABC will not have a
loan balance that needs to be repaid, Smith
will receive more death benefit protection
and own all the policy’s cash value. This
strategy will likely grow Smith’s supplemental retirement savings faster. ABC will be
able to deduct the bonus (assuming Smith’s
total compensation, including the annual
bonus, is reasonable), so its net cash flow
will improve. The biggest disadvantage to
ABC is that it will not be able to recover the
bonuses if Smith dies or leaves the company.
4. The Bonus/Loan Match. While Smith
will like the bonus match strategy, ABC
may find it less appealing. That’s because it
retains no control over the benefit and can’t
recover any of its costs when Smith retires
or leaves. The bonus/loan match plan (also
known as the hybrid executive benefit, or
“HEX benefit” strategy) combines the loan
match and bonus match strategies into a
hybrid approach that has benefits for both
Smith and ABC. Instead of contributing by
either a loan or a bonus, ABC will do both—
it will match Smith’s $10,000 with a $5,000
loan and a $5,000 bonus. Smith will execute
a collateral assignment of the policy to ABC
to secure repayment of the loan balance.
Businesses like this strategy for several
reasons:
• They get an immediate income tax
deduction for the bonus portion of the
premium.
• They control the policy through the
loan and the collateral assignment.
• The plan is flexible so, from year to
year, they can change how much they
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Table 1: Skinny Benefits Comparison Table
Issues
Deferral Match
Loan Match
Bonus Match
Bonus + Loan Match
Premium Deductibility
NoNo Yes
for Business
Control of Policy
Bonus Portion
Deductible
BusinessBusiness BusinessBusiness
Cost Recovery for
YesYes No
Business
Flexibility–Ability
to Change Terms
Amount Taxable
to Employee
Portability
LimitedYes
Yes
Yes
No Tax Until Benefits
Loan Not Taxable
Bonus Is Taxable
Paid at Retirement
No
Yes (Repay Loans)
Potential 409A PenaltiesYes
Administration Costs
Loan Portion
Recoverable
Yes
contribute and how it is allocated between
loans and bonuses.
• The loan balance is an asset on their
balance sheet.
• Administration is relatively simple—
the loans need to be documented and
interest must be accounted for.
• The loan balance provides some cost
recovery potential.
Key employees also like the strategy
because:
• They own the policy and its accompanying death benefits and cash values
(subject to the collateral assignment).
• Only the bonus portion of the policy
is taxable.
• The policy is portable so they can take
it with them if they leave the company (the
loan balance will need to be repaid).
• Remaining policy cash values may
help supplement their retirement income.
Adding Flexibility With Benefit “Ladders”
A valuable aspect of skinny benefits is
that it is possible to string several benefits
together to keep key employees engaged.
These benefit strings are called “executive
benefit ladders” and they can increase
the overall value of the incentive plan to
the employee over time. When used in a
series, they can build on each other and give
businesses more flexibility in providing
No
No (Track Interest)
Bonus Portion
Is Taxable
Yes
Yes (Repay Loans)
No
No
No
No (Track Interest)
Table 2: Executive Benefit Ladders
Employee Owns the Policy
Business Owns the Policy
Deferral Match + Endorsement Split Dollar
Double Bonus Match
Deferral Match + Death Benefit Only Plan
Bonus Match
Deferral Match
Loan/Bonus Match
selective benefits. These ladders can help
businesses adapt to new situations and
avoid a key employee’s “what have you
done for me lately?” concerns.
This is apparent in skinny benefits in
which the key employee owns the policy.
For example, ABC can begin by offering
Smith the loan match option. After several
years it can “upgrade” Smith’s benefit by
adding a bonus element to the match and
reducing the amount of the loan component—the bonus/loan match (the HEX
benefit). After several more years, ABC can
upgrade the benefit again by eliminating
Reprinted from BROKER WORLD April 2015
Used with permission from Insurance Publications Loan Match
the loan component and going to a bonus
match plan. Finally, it could increase the
size of the bonus enough to create a “double
bonus” to help Smith pay the taxes.
Incentive plans in which the business
owns the policy are usually more restrictive
because they often fall under IRC Section
409A. Still, it is possible to build a benefit
ladder. For example, ABC can begin the
plan with the deferral match (the 401(k)
look-alike plan). After several years it can
add a protection component for Smith’s
family by adding a death benefit only
(DBO) benefit if Smith dies before retiring.
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Later it can upgrade this part of the plan
by instituting an endorsement split dollar
(ESD) plan which should make that pre-retirement death benefit income tax-free for
Smith’s beneficiaries. ABC will own the
policy at all times, but by adding DBO and
then ESD elements, it can create more value
for Smith and his family.
Conclusion
Most key employees will need to save
money in order to enjoy a financially
secure retirement. They’ll be able to retire
sooner and/or more comfortably if their
business is willing to help. Employers can
work with their employees to help them
build retirement funds while keeping the
business strong and profitable. Businesses
that understand the importance of recognizing their key employees’ work are open
to creating incentives to motivate them
to continue their high level performance.
Skinny benefits are flexible incentive strategies that can help keep key employees
engaged and productive for the balance of
their careers. 
Reprinted from BROKER WORLD April 2015
Used with permission from Insurance Publications These materials are not intended to and cannot be used
to avoid tax penalties and they were prepared to support
the promotion or marketing of the matters addressed in
this document. Each taxpayer should seek advice from an
independent tax advisor.
The Voya Life Companies and their agents and representatives do not give tax or legal advice. This information
is general in nature and not comprehensive, the applicable
laws change frequently and the strategies suggested may
not be suitable for everyone. You should seek advice from
your tax and legal advisors regarding your individual
situation.
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